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Arthur Laffer you’re embarrassing yourself

During George W. Bush’s years as president I most say that I lost a lot of respect for Paul Krugman. It was very clear that he was suffering from what Charles Krauthammer called the “Bush Derangement Syndrome” (BDS). BDS undoubtedly made Krugman write crackpot articles about all kind of subjects. Krugman for example on numerous occasions has argued in favour of protectionism – something the pre-Bush Krugman would never have done.

Unfortunately, this President Derangement Syndrome (PDS) has infected a number of US right-wing economists who used to be clever economists, but today seem to have forgotten everything about economics – mostly as a result of an apparent hatred of President Obama. I am no fan of President Obama, but I do not let that change my view of economics.

I have earlier highlighted that I think that Allan Meltzer who is one of my great monetarist heroes seems to have forgotten everything about monetary theory that he once preached exactly because of PDS. Unfortunately he is not the only right-wing US economist to suffer from PDS. The latest example is supply-side hero Arthur Laffer who frankly is embarrassing himself in a recent Wall Street Journal article.

The stated purpose of Laffer’s article is to show that “in country after country, increased government spending acted more like a depressant than a stimulant.”

Anybody who reads my blog would know that I am certainly no fan of “fiscal stimulus” and that I believe that fiscal policy can not “overrule” monetary policy. Hence, I believe in the so-called Sumner Critique. Furthermore, I strongly believe that there is good empirical evidence that a larger government is a drag on the economy and that more government spending in general will tend to reduce productivity growth in the longer run. Hence, I strongly agree with Laffer in terms of the overall view that fiscal stimulus is unlikely to be helpful in getting us out of this crisis and in the long run a larger public sector is likely to hamper growth.

However, even though I agree on Laffer’s skeptical view of fiscal stimulus I nonetheless find his “analysis” to be shockingly bad.

In his analysis Laffer compares the change in real GDP growth from 2006-2007 to 2008-2009 with the change in government spending in the same period in different OECD countries. (By the way look Laffer’s numbers look very odd – David Glasner discusses that in his post on Laffer here.) Here is Laffer’s somewhat surprising conclusion:

“The four nations—Estonia, Ireland, the Slovak Republic and Finland—with the biggest stimulus programs had the steepest declines in growth.”

Are you joking Art?? Estonia? Biggest stimulus program? You can’t seriously think so. I think Prime Minister Ansip of Estonia would be rather upset that you say that his government apparently has conducted some kind of Keynesian fiscal stimulus. I know for a fact that Mr. Ansip has no respect for Keynesian fiscal stimulus. In fact his government has rightly been praised for its conservative fiscal stance.

Mr. Ansip’s government has since the crisis hit in 2008 (in fact it already started in 2007 in Estonia) passed significant austerity measures such as cutting public sector wages and pensions. Mr. Ansip’s government has shown an enormous commitment to reducing the budget deficit and reining in the public debt. In fact by saying what you are saying Mr. Laffer you are making a mockery of the truly remarkable fiscal consolidation in Estonia.

Estonia by far has the lowest debt-to-GDP ratio in the OECD area so how Mr. Laffer can claim that Estonia is an example of an evil Keynesian experiment is somewhat of a puzzle to me. The limit for public debt in the EU is 60% of GDP. Estonia’s public debt is 6% (!) of GDP. And Estonia is running a public finance SURPLUS!

But ok, lets say that Mr. Laffer made one mistakes in his assessment. The three other countries have to be irresponsible countries. No! They are certainly not. In fact Finland and Slovakia are both in the group of the most fiscally conservative countries in the EU and the markets agree. Just look at Finnish and Slovakian bond yields. In fact few market participants would question the creditworthiness of Finland. After all Finland has a BETTER credit rating than Germany! Finnish government bond yields is basically at the same level as German bond yields.

So how about Ireland? It is true that the country has seen a sharp rise in public debt since 2008. However, that can hardly been seen as a result of “fiscal stimulus”. The rise in public debt is mostly due to banking rescues in 2008 and 2009, which of course can be questioned whether that has been a good idea, but you can hardly say that Ireland has conducted keyensian style fiscal stimulus. Furthermore, after the sharp rise in public debt consecutive Irish governments have put a lot of effort into fiscal consolidation and Ireland has rightly been praised for its effort to curb public debt. As a result Ireland is generally perceived more positively by the markets and credit rating agencies than the other so-called PIIGS countries.

So we can easily conclude that Arthur Laffer got it completely wrong. So why is that? Well, maybe he never heard about cyclically adjusted government spending. It should be no surprise to anybody who just spent one hour reading an intermediate textbook on public finances that government spending tend to increase in cyclical downturns and tax revenues drop when the economy slumps.

Estonia in 2007-2010 went through a Great Depression sized collapse in economic activity and hence it is no surprise that that led to an increase in public spending as outlays to unemployment benefits and other social benefits rose sharply. To its credit the Estonian government reacted to this worsening of public finances by putting through significant austerity measures. Mr. Laffer, however, in his eagerness to badmouth President Obama’s fiscal policies forgets this and knowingly or unknowingly trashes the heroic fiscal performance of Mr. Ansip’s Estonian government. I think an excuse would be in order.

I am sorry to say it, but Mr. Laffer’s article is yet another example of right-wing US economists that for the sake of partisan politics completely trash all economic logic. That is too bad, because Mr. Laffer could instead have told the story of the great example of Estonia, a country that is gradually coming out of this crisis WITHOUT fiscal stimulus. He could also have told the story about Greece’s and Spain’s fiscal stimulus packages of 2009 that did a lot to increase these countries’ public debt levels. He could also have told the story about how fiscally conservative policies have ensured that Finland is the country in Europe with the best credit rating.

I strongly believe that less public spending is positive for long-term growth (and that is a supply-side argument Mr. Laffer!) and I doubt that fiscal stimulus (without monetary stimulus) will do much to increase growth in the short-run, but I have far better arguments than Mr. Laffer.

I think it is about time that my fellow free market economist friends in the US start to behave as economists rather than playing party politics. That would strengthen the case for free markets and less government intervention. By playing party politics economists like Allan Meltzer and Arthur Laffer are not doing the cause much service.

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PS I use the term “right-wing” economist above to mean an economist who generally is in favour of free markets and generally opposes government intervention in the economy. In that sense I am obviously a right-wing economist myself.

Update: Brad DeLong also has a comment on Laffer’s WSJ piece. I am getting tired of agreeing with him and Krugman in their criticism of (certain!) “right-wing” economists.
Update 2: Karl Smith joins the debate.
Update 3: And here is Matt O’Brien on the same topic – with a golden quote: “He really is the anti-Keynes. When the facts change, Laffer changes the facts back, so he won’t have to change his mind.”

24 Comments

Ken Renner

Laffer has outdone himself with nonsense this time – and it’s even worse than you portray it. He confuses things happening at the same time with things that are statistically correlated and those where causation can be show, This is a prime example of how one should not misuse data and reach false conclusions.

His premise is that stimulus spending slows growth. As evidence, he shows that many countries increased increased spending from 2007 – 2009, which is fairly common in all cases over a three-year period but especially during economic downturns. He claims that this made GDP fall. Yes, these things happened at the same time but is there a correlation or can we say that spending caused the drop in GDP?

Here’s a similar example to Laffer’s. A ship is sailing across the ocean when it is buffeted by a huge storm. Many of its passengers are swept overboard and the crew throws them life preservers, yet quite a few still drown. By Laffer’s logic, the crew made a big mistake since throwing life preservers to the passengers obviously caused them to drown.

In both Laffer’s example and mine, there is not a shred of evidence to support a conclusion that one action caused the result. In fact, even using Laffer’s own data, there is barely any correlation between stimulus spending and a fall in GDP. Looking at his own data, Korea and Switzerland increased spending less than 1%, yet had falls in GDP of well over 7%. Hungary shrank spending by 0.2% and GDP still fell nearly 10%. Several other countries increased spending yet had GDP losses well below those who held the line on government outlays. Maybe something besides spending was a cause?

In my example, it was obviously the storm that caused people to drown, not the act of throwing them life preservers. In Laffers’ example, the life preserver of stimulus spending didn’t cause the losses of GDP, it was the economic storm going on across the globe.

In fact, a more persuasive case can be made that those countries with the worst reductions in GDP decided to spend more in an effort to remedy the problem. This would create precisely the correlation that Laffer seeks, yet reverse the causation.

Ken, I fully agree. I was not trying to be nice to Laffer (even though I hope I could have been), but I simply didn’t want to write about ALL of the errors. We all know that if any student of statistics or economics put this kind of thing in to paper they would flunk.

cthorm

Good show Lars. If you’ll recall, Art Laffer’s famous curve was drawn on a napkin. It is not his style to have a very thorough (or accurate) analysis. My father and his business partners have subscribed to his newsletter for years, so I’ve read plenty of his work, and I was rarely impressed with the analysis, though I normally find the thrust of the argument to be more or less right. It’s a shame he is so sought after as a pundit when younger contemporaries, like Veronique de Rugy (to name an academic who has made a similar argument), do a much better job at providing actual evidence.

Benjamin Cole

There is a tiresome game, evidently eternal, of selecting a few nations that are either prospering or floundering, and then ascribing the success or failure of said nations to one’s prevailing political/economic beliefs.

Laffer wasn’t able to fo even that, and so just made stuff up.

Of course, the failure or success of nations is based on many factors, some beyond the reach of economics, such as work ethic and corruption in government. There is luck too–Mideast nations have oil.

Japan proves that monetary policy is crucial, but proves little else. Yet many used to ascribe its success to various right-wing or left-wing pet beliefs.

Like Lars, in general I prefer free enterprise and limited government. I just wish there was a political party in the USA I could vote for.

The USA right-wing has gone bananas of late, worshipping gold and military adventures, and towering rural subsidies. The Bush Administration was a train wreck into a sewage treatment plant. And we want the GOP back in power?

Glenn

“The stated purpose of Laffer’s article is to show that “in country after country, increased government spending acted more like a depressant than a stimulant.” and you say you agree with him.!? I notice you bring a lot of stuff, monetary policy, public debt…but what do they have to do with Laffer’s basic premise? The table shows other tighter economies having crushing negative growth but that can be explained and doesn’t detract from his statement that increased spending does not buy you out of a hole. The table shows that Krugman like spending boosts have not worked regardless of if you call Estonai “stimulus” or not.
Seems to me, at best, this should be titled “Laffer’s methods are not deep or sharp, but i agree with his premise!”
Maybe an apology.

Public spending adjusted for inflation DROPPED by nearly 5% from 2008 when the crisis hit and until 2010. In the same period economic growth collapsed – real GDP contracted more than 14%. In 2009 real public spending in Estonia DROPPED.

Glenn

So, the figures in the table are incorrect? You say spending in 2009. I thought the figures were TO 2009, 2007 to 2009. In 2009 is something different. Laffer’s table doesn’t show IN 2009. Either the number is right or wrong. Yes, to relate Estonia to stimulus is going to far but it seems economists are stumbling over each other to get noticed. The main thing is, you AGREE with the basics. Well, sir, people are certainly leaving that out and using you, since you put yourself in the position to do so.

I don’t agree with Laffer’s analysis. In fact I believe that he is doing serious harm to his own reputation and further makes it very hard to be taken serious when questioning that fiscal stimulus would be a good idea.

In the case of the US I don’t think fiscal easing is warranted. I believe that the Federal Reserve should move to ease monetary policy aggressively.

The figures in Laffer’s table are correct, but it just not say ANYTHING about the size of fiscal stimulus in 2009 for example. In the case of Estonia public spending DROP measured in constant prices in 2009 and 2010. So there was no easing of fiscal policy. There was a tigthening of fiscal policy. In 2006 and 2007 fiscal policy was indeed eased, but that was PRIOR to the crisis.

I am afraid Laffer has no clue about the policies implemented in Estonia. I have and I was indeed very critical in 2006-7 about the overly loose fiscal policy in the country when the economy was booming. I also supported fiscal austerity in 2009-10.

If Laffer want to write article about economic he should study the fact and not try to make the facts fit his story. This is not a left-right issue. It is simply about professional honesty.

Glenn

I’m confused. You say you agree generally with Laffer on fiscal policy, but not his methods. You say the numbers are correct in the table. Well, Laffer and the table doesn’t even address what happens in 2010, so why do you bring it up? There are some relationships that jump out of the table, maybe anecdotal for now, but some definite patterns. As Laffer said, the countries with the worst ratio of spending to GDP in 2007 thru 2008 are also the ones with the worse growth. Now, i consider using the term stimulus to describe Estonia misses the mark, but “embarrassing” himself!? You can also see that countries with tighter belts had the shallowest holes. There are some other points he made that are well worth considering, such as the false “multiplier” liberals give to government spending. I am not an economist and i am concerned about fiscal matters to the hell with politics. I did want to say that Lefties are using your article while leaving out some things. They quote you as a “Right Wing” economist.
Art Laffer should be more rigorous for sure but he always provokes and his conclusions make sense in some way.

First of all, this is not a left-right issue. This is a simple discussion about whether Art Laffer manipulate the numbers to suite a certain story he wants to tell. In the process he belittles the fiscal consolidation made in Estonia. An effort that have gotten a lot of praise by free markets around the world. Now Laffer is spreading a story that Estonian government was irresponsible keynesians. Do you think that is right? Do you think it is ok to manipulate for the sake of winning the political argument? That might be something politicians do, but if you are supposed to be a world famous respectable economist you better get the facts right.

It is very clear to me that Laffer has very little knowledge of what is going on in the Europe. He demonstrate that by claiming that countries like Estonia and Finland had Keynesian policies. Furthermore, it is obvious that he puts political gains above profession integrity. He might be willing to do that, but I will not do it.

Glenn

“The four nations—Estonia, Ireland, the Slovak Republic and Finland—with the biggest stimulus programs had the steepest declines in growth. The United States was no different, with greater spending (up 7.3%) followed by far lower growth rates (down 8.4%).”

I do have a problem with this. It is wrong. Estonia did not have a stimulus program. And Our results were more mild than most on the table and we spent trillions.

The problem i have is support for Keynesian nonsense. I do not understand why Krugman isn’t ridiculed in much the same way.

Laffer’s table looks like a refutation of Keynes, like Laffer says.
Krugman says open the tap, loosen policy, It’s all the same, GDP!

Also, these matters should examined across the years. I am always leery of “Between 2007 and 2009”!
Thank you for your replies. i appreciate you.